What The Markets Are Really Waiting For…
Many Asian EMs
are consolidating sharp gains while developed markets attempt to extrapolate
economic reports. Global markets are leaning toward discounting an accelerating
economic recovery. But many investors and traders are still reluctant to believe
that the current massive fiscal and monetary policy stimulus occurring globally
can produce any kind of self-sustaining upward momentum for very long.
Capital spending HAS recovered
some, and that’s something the naysayers didn’t think would happen.
But what the markets are really waiting for in order to buy fully into the accelerating
global recovery scenario is some evidence of employment growth. Japan has employment
growth, and its market is therefore leading performance of developed markets
in this rally so far. In the US, economists are still complaining — first
it was about the “profitless recovery†but then profits started
to recover from productivity gains and cost-efficiency gains. Next, it was the
“recovery without capital spending†but then capital spending starting
growing some; and now it is the “employment-less recovery.†I have
even seen some commentators discussing the “dark side of productivity
gains†that don’t produce jobs, supposedly.
It is true indeed that employment
does LAG productivity growth, but if you ever hear anyone talking about the
“dark side of productivity gains,†please run for the nearest exit
before dying of laughter. Productivity gains are what produce the ability for
employers to pay higher wages and hire more labor, pure and simple. The only
dark side to productivity gains is that there aren’t more of them!
We therefore strongly suspect
that just as hiring plans and leading employment indicators are now pointing
up, employment will actually improve in the quarters ahead, and the recovery
will take on a self-sustaining element, absent major shocks. The problem with
this massive global liquidity infusion isn’t likely to be that its effects
won’t happen, but that they will overshoot and lead to faster inflation
than anyone is expecting, as well as higher interest rates more quickly than
normal.
Our base scenario remains
on track, and is growing in likelihood. While the market could easily undergo
a minor correction taking many weeks at any time, we would expect a recovery
to develop as economic news continues to confirm our base scenario. It is looking
increasingly like a much stronger growth period than markets are anticipating,
is ahead. Asia should continue to lead on the upside, although a consolidation
or correction is long overdue. Our favorite markets are small-cap Emerging Markets
in general, Asia in general, Thailand, metals and resources, South Africa, Eastern
Europe, Chile, China, India, and Latin America in general.
Investors should continue
to monitor the potential party killers — 1) over 4.75% on 10-year government
bonds (more reprieve here); 2) oil over $38-$40 (much more reprieve here, though
$25 should hold); 3) a fast-plummeting dollar (watch for new highs in AUD, NZD,
and CAD to announce next dollar leg down); and 4) a CLEAR and strong successful
terrorist attack in the US or on a major US installation.
The euro is rallying in
a trading range now and is volatile. Letting a moribund central bank manage
your currency and hamstringing your budget policies (unless you are Germany
or France where budget constraints can be overlooked), doesn’t seem to
appeal to the likes of Switzerland, Denmark, UK, and now Sweden — and
this may prevent the euro from being able to replace the trashed dollar nearly
as far as some thought earlier this year. Nonetheless, the dollar is probably
in a secular decline. Watch for breakouts to new highs in AUD, NZD, and CAD
for the announcement of a new leg down in the dollar. Will the Japanese allow
the yen to move through 115 after the election is over this weekend? If so,
a quick move to 100 may be in the making.
Gold and silver and related
stocks continue to creep ever higher in what we suspect are the early stages
of a new secular advance. But remember these metal plays are always VOLATILE.
Also moving up nicely are base metal and other resource plays, particularly
those that are feeding the demand growth of China (which is why Thailand has
been one of our favored markets for so long). The CRB should continue higher
before 229 is breached after last week’s breakout, as should industrial
commodities in particular (Rogers Raw Materials Fund).
Internal breadth tools improved
in terms of leadership and volume somewhat, but we also had another week WITHOUT
20 new highs each day in our Top RS/EPS New Highs list, though breakouts expanded.
We had nice breakouts Thursday on a large number of financials and financial
indexes as well as most broad US indexes.
Investors should continue to cautiously add stock exposure as trade signals
are generated that meet our strict criteria, as well as allocate to our favorite
segments. Our model portfolio followed in TradingMarkets.com with specific entry/exit/ops
levels from 1999 through May of 2003 was up 41% in 1999, 82% in 2000, 16.5%
in 2001, 7.58% in 2002, and we stopped specific recommendations up around 5%
in May 2003 (strict following of our US only methodologies should have portfolios
up over 14% ytd by our calculations) — all on worst drawdown of under
7%.
Last week in our Top RS/EPS
New Highs list published on TradingMarkets.com, we had readings of 13, 19, 40,
40, and 65, accompanied by 11 breakouts of 4+ week ranges, no valid trades one
close call in PETD. Position in valid 4 week trading range breakouts on stocks
meeting our criteria or in close calls that are in clearly leading industries,
in a diversified fashion. Bottom RS/EPS New Lows are still quite weak with readings
of 4, 1, 2, 3, and 2, and no breakdowns of a 4+ week range. The short-side remains
bleak. Selling pressure is very low — the problem is that buying power
is just mediocre.
For those not familiar with
our long/short strategies, we suggest you review my book, The Hedge Fund Edge,
my course “The Science of Trading,” my video seminar, where I discuss
many new techniques, and my latest educational product, the interactive training
module. Basically, we have rigorous criteria for potential long stocks that
we call “up-fuel,” as well as rigorous criteria for potential short
stocks that we call “down-fuel.” Each day we review the list of new
highs on our “Top RS and EPS New High List” published on TradingMarkets.com
for breakouts of four-week or longer flags, or of valid cup-and-handles of more
than four weeks. Buy trades are taken only on valid breakouts of stocks that
also meet our up-fuel criteria.
Shorts are similarly taken
only in stocks meeting our down-fuel criteria that have valid breakdowns of
four-plus-week flags or cup and handles on the downside. In the U.S. market,
continue to only buy or short stocks in leading or lagging industries according
to our group and sub-group new high and low lists. We continue to buy new long
signals and sell short new short signals until our portfolio is 100% long and
100% short (less aggressive investors stop at 50% long and 50% short). In early
March of 2000, we took half-profits on nearly all positions and lightened up
considerably as a sea of change in the new-economy/old-economy theme appeared
to be upon us. We’ve been effectively defensive ever since.
On the long side we like
SFNT, AVID and UNTD still, the close call from this week, PETD, and other recent
close calls from past weeks, RTIX, GMR, VSTA, STFC, VMSI, WES, PKOH, FDRY, BNT,
WR, WLS, NCEB, and FCX, as well as in our favorite global sectors. No short-side
opportunities have developed via our strategy for some time. We also like conservative
gold stocks, like FCX and NEM, small-cap Emerging Markets in general, Asia in
general, Thailand, metals and resources, South Africa, Eastern Europe, Chile,
China, India, and Latin America in general.
The new leg up is tentative
and will be nervous upon excuses to correct and consolidate. But it should march
higher, two steps forward and one step back as long as liquidity is plentiful,
global economic acceleration continues, and breadth holds up. But instead of
the normal pattern of liking a market more the stronger it gets, in this expected
mini-bull move, investors should be growing more cautious as the market rallies
from here.
Mark Boucher